Equity Crowdfunding – The Great Unknown

Admittedly, we’ve already dedicated a seemingly disproportionate amount of blog space to the subject of equity crowdfunding (EC), yet, this issue remains the “elephant in the room” of many future funding discussions. Sometimes this issue is explicitly addressed as it was at the recent Clean Business Investment Summit at UCSB in Santa Barbara where several of the keynotes and panel discussions speculated about the future impact of equity crowdfunding. The reality is that, at this point, still a great deal is unknown about how the equity crowdfunding process will look when finally approved by the SEC and therefore its impact is subject to a great deal of uncertainty. The wide range of possible outcomes means that the effect of equity crowdfunding could range anywhere from becoming the dominant form of startup funding (Seed and Series A) to actually having a negative impact of the availability of funds. To understand this tremendous variability in the outlook for equity crowdfunding look at a couple current, real-world examples. In the most optimistic scenario (which assumes you’re in favor of EC) equity crowdfunding would look like projects that you currently see on crowdfunding websites such as Kickstarter and Indiegogo. In this scenario a startup could raise a $1 million in equity simply by listing their investment opportunity on a legitimate site* and solicit $100 each from 10,000 non-accredited investors. The appeal of this is obvious for both sides as it presents a relatively quick and easy funding process for the startup and a relatively low-risk (in terms of the amount committed capital) opportunity for the investors. To understand the opposite end of the spectrum look at the revised regulations that are about to go into effect for General Solicitations. The change will allow public advertising and promotion of private equity offerings, a practice that has been prohibited under current statutes. While the intent of this change was to increase the availability of capital for startups, provisions in the new regulation could have a contrary impact. The regulation will now require specific verification of accredited investor status. Currently investors only need to sign a document stating that they meet the minimum income or net investable asset threshold as qualifying as accredited investors. Under the new law the company or their investment bankers must verify this status through means such as a review of recent tax returns. In a classic example of unintended consequences, many investment professionals believe that this requirement will serve to deter investors thereby resulting in a reduced availability of capital for startups. These professionals are also concerned that the same could occur with the equity crowdfunding aspect of the JOBS Act if it places too onerous a burden on the companies and/or the investors. One of the main functions of the SEC is to protect individual investors and, given the lack of sophistication of non-accredited investors, it is very possible that the SEC will impose significant audit, reporting and investor communication requirements in order to adequately protect these individuals. Ironically these requirements could prove to be so costly for companies that they elect not to pursue the very program that was intended to provide them with access to capital in the first place. The challenge of balancing protection for investors while facilitating a new form of startup funding is the reason we have yet to see an approved equity crowdfunding process issued by the SEC and are unlikely to see one before 2014. Until then we will be left to speculate with regard to what it will look like, when it will be enacted and what impact, if any, it will have on the availability of funding for startups.

*The SEC will require sites to be FINRA compliant and transactions to be handled through registered represents of listed Broker/Dealers.